3.2.2 Investment appraisal 💸 Flashcards
What is investment appraisal?
Attempts to determine the value of capital expenditure per project - enables the business to compare projects
business can expand and meet the objectives
Eg . profit maximisation and efficiency
What is the planning process ?
Used to determine with the long-term investments will give best return
Eg . Machinery
New premises
What are the two techniques for planning processes?
What do they take into account and how do we calculate them ?
Simple payback -
Add the amount needed to pay per year without overdoing your expenditure
Subtract what you have left with the next year
left to pay/cash flow prediction of that year * 12
For your answer you put the year it’ll be paid plus your answer
ARR -
Takes into account the rate of return and profitability
Find profit
you add up your inflows from year one to 5
minus the original cost
Divide by the number of years
your project runs for
and then divide by the cost 
What is NPV and how do we calculate it?
Net present value and discounted cash flow
takes into account the money in the future isn’t worth what it is today - discount table - realistic 
Multiply figures with discount cash flow add the up
then subtract it from the cost
What is the formula for ARR
Average annual profit/Initial capital Overlay *100
What are the advantages of the simple payback method?
Useful when technology changes rapidly going to recover the cost of investment before new designs
it simple to use
Firms may adapt this method if they have cash flow problems - because project chosen will pay back the investment more quickly
What are the advantages of the ARR method?
Shows the capability of investment project - Allows other projects to be compared and shows overall return 
Easier to identify the opportunity costs of investments 
What are the advantages of NPV ?
Accurately accounts the value of future earnings by calculating present values
could be used as risk and conditions of financial markets change
NOT INFLATION!!!
What are the limitations of simple payback?
Cash earned after payback period is ignored So profitability of Method is overlooked
What are the drawbacks of ARR ?
The effect of time on the value of money is ignored
What is the limitations of NPV?
Calculations is more complex
Rate of discount is critical if I did the
Profitability of projects will be fewer
How do we Calculate simple payback?
Cost of initial investment/ Average yearly net cash flow 
